McDonald's mid-life crisis

An exclusive survey finds the fast-food giant risks leaving its Happy Meal days behind, if it can't adapt to changing markets. Illustration by James Bennett

Soon after taking over the top slot at McDonald's Corp. in August 1998, Jack M. Greenberg waxed expansive about the company's future, as only a newly minted CEO can.

Soon after taking over the top slot at McDonald's Corp. in August 1998, Jack M. Greenberg waxed expansive about the company's future, as only a newly minted CEO can.

"We will reinvent the category in which we compete," the president and CEO wrote in a memo to the Oak Brook-based chain's employees and franchisees — bold words for a 44-year-old icon that had built its empire on a fast-food foundation selling mainly hamburgers, fries and shakes, while expanding into nearly every corner of the country and beyond.

But as McDonald's enters middle age, there are much weightier concerns than reinventing product categories. McDonald's must reinvent itself.

While management appears willing to tackle that task, it also confronts a disturbing question: Can McDonald's regain the vigor of youth, or are its Happy Meal days behind it? For example, earnings per share grew an anemic 5% last year.

To reclaim its berth as a growth-oriented corporation firmly entrenched in the upper echelon of U.S.-based companies, McDonald's must first overcome a number of significant — perhaps insurmountable — challenges, many of which are identified in an extensive and exclusive survey conducted for Crain's by Chicago-based market research firm Leo J. Shapiro & Associates LLC.

Indeed, the Crain's survey portrays a company being bombarded on many of its once-secure fronts.

Hurting here and abroad

In the U.S., there are too many free-standing restaurants, and the inability to build more limits the company's domestic growth potential. Overseas, McDonald's is hurting because of its rapid store expansion and an outbreak of mad cow disease, which is depressing beef sales throughout Europe.

Perhaps most alarming is McDonald's tenuous relationship with customers, revealed in their perceptions of its constantly evolving menu — a confusing array of products, meal deals and prices. For instance, the Crain's survey finds that only 23% of recent McDonald's customers prefer McDonald's hamburgers to those sold at other chains.

'Riding up its growth curve'

In view of its troubles, Wall Street is unhappy with the company. Investors have been unloading its stock — the price is down 36% since January 2000, and about 18% since Mr. Greenberg took over as CEO.

"It's a classic story of a company that's riding up its growth curve," says Trent Webster, portfolio manager of the Florida State Board of Administration, a McDonald's shareholder. "I don't think it's a broken business model. They're just trying to find ways to grow . . . and that's difficult because it's a mature business."

The company's main domestic growth strategy in the past — building more restaurants — is not a viable option in today's saturated fast-food market. So, McDonald's has been trying to find new ways to squeeze more sales out of its 12,800 existing U.S. restaurants. It has changed its advertising, rolled out a made-to-order cooking system and launched a new rotating menu, offering everything from chicken wings to bacon-egg-and-cheese bagels.

That's "the only way they're going to move the needle domestically," says Dennis Lombardi, executive vice-president of Technomic Inc., a Chicago-based restaurant consulting firm. "Even if you add $50,000 a store, that's a lot of money dropping to the bottom line."

Growing the menu

McDonald's executives have set the bar high, touting their "blueprint for growth," a plan to double the company's domestic systemwide sales by the end of the decade. But many analysts doubt that's an attainable goal, considering that systemwide sales in the U.S. rose only 3% last year.

A lot will ride on the company's Made for You cooking system, which McDonald's began rolling out nationally in 1998.

Made for You enables restaurants to prepare food based on actual orders. Under the old batch cooking system, the restaurants prepared food on the basis of projected demand, which meant that Big Macs often were left sitting under hot lamps until the front counter rang up an order for one.

McDonald's not only aims to boost food quality and freshness with Made for You, but also expects it to spur new product innovation — traditionally a weak area for the company, which hasn't had a major new product hit since it introduced Chicken McNuggets back in 1983. In fact, McDonald's past is littered with product-innovation busts like the McLean Deluxe, the McDLT and the Arch Deluxe.

Made for You made possible the recent introduction of McDonald's New Tastes Menu, a rotating menu of 40 items, including the Big N' Tasty Burger and BBQ Bacon Crispy Chicken sandwich. McDonald's restaurants can add four of these items to the basic menu at any one time.

Yet the Crain's survey indicates that most consumers aren't crying out for more menu variety. Only 29% of respondents say they would be more inclined to visit a McDonald's if the restaurant offered a new sandwich, while 11% said they'd be less inclined and 60% said it wouldn't make any difference in their decision.

Taking 'fast' out of 'fast food'

Equally significant is the fact that Made For You has fallen short of the expectations of some analysts and investors, who point out that instead of boosting same-store sales, the cooking system has led to longer waiting times at many restaurants.

"There was a time when you could call it fast food, but you can't call it that anymore because it's not fast," says Mr. Webster, the Florida portfolio manager.

Mr. Feldman defends Made for You, noting that drive-through times and food quality have improved since the system was rolled out. While acknowledging that "we still have our challenges with service," Mr. Feldman says the problems have more to do with the tight labor market than with the Made for You system.

Part of the challenge facing McDonald's — and many other companies in the food-service business — is finding a way to motivate the young workers who flip burgers at its restaurants. Among respondents to another Shapiro survey who were polled about their attitudes toward work, only 41% of those younger than 30 say they should work as hard as possible in their jobs, compared with 51% of respondents ages 30 to 49 and 74% of those 50 to 59.

'Golden Arches Food Court'

McDonald's future growth also depends on the success of its other restaurant concepts: Donatos Pizza, Chipotle Mexican Grill and Boston Market in the United States and the Aroma Cafe coffee chain and Pret A Manger snack and sandwich chain in Europe.

Sales from McDonald's other brands soared to $605 million last year, up from $91 million in 1999, largely because of its acquisition of Boston Market.

Yet investors expecting the brands to provide a meaningful boost to earnings anytime soon will be disappointed. With systemwide sales of $40 billion, McDonald's is so big that even if its other concepts expand aggressively, they will still account for less than 10% of the company's operating profits a decade from now, forecasts John S. Glass, an analyst at Deutsche Banc Alex. Brown in New York.

Says Timothy Ghriskey, a senior portfolio manager at Dreyfus Corp., a New York money manager and big McDonald's shareholder: "We worry that perhaps (the other brands) are yet another distraction. They're not going to be a driver of fundamentals of the earnings or stock, except to the extent that they divert management's focus."

The Crain's survey, however, suggests that consumers are receptive to the idea of McDonald's operating other fast-food concepts, provided they adhere to the same principles of convenience and consistency that enabled the company to develop into a powerhouse hamburger franchise.

Indeed, Leo J. Shapiro & Associates Chairman George Rosenbaum, who oversaw the survey, contends that the other restaurant concepts are a way for McDonald's to learn how to leverage its strengths in restaurant operations to pizza, burritos and other foods. "What they're trying to do is get an effective feeding formula for different kinds of food," he says.

Pointing to his research, Mr. Rosenbaum suggests a "Golden Arches Food Court," where McDonald's could serve a wide variety of foods, but through different restaurant formats.

For now, however, McDonald's executives have plenty of other worries. One is mad cow disease, which has depressed demand for McDonald's hamburgers in Europe, where more than a third of the company's operating profits are generated.

Analysts give McDonald's credit for its response to the crisis, which has included more promotions for chicken and pork items on its European menus.

While there have been no reported cases in the United States, 15% of consumers in the Crain's survey say mad cow disease is a U.S. problem.

Currency woes

Meanwhile, McDonald's is dogged by another problem beyond its control: weak foreign currencies, which reduce its profits when it repatriates them to the United States. McDonald's reported a 4% gain in systemwide sales last year; excluding the impact of currency translations, sales would have risen 7%.

Weak overseas currencies and mad cow disease are the chief reasons for the company's recent poor results. For the first quarter, earnings per share fell 12%, after rising a disappointing 5% for all of 2000.

Analysts are confident that mad cow and currency problems eventually will pass, but some are more concerned about the company's aggressive international expansion: More than 1,300 restaurants were added in Europe, Asia and Latin America last year.

Though the strategy may pay off several years down the road, it's hurting the company's profitability now, and some in the investment community are urging management to scale back (see story, this issue).

"The ultimate question, in our minds, is whether McDonald's has overinvested in risky new markets or has simply had a run of bad luck that has depressed earnings and returns," Mr. Glass, the Deutsche Banc analyst, wrote in a recent research report. "We'd argue that it is probably a little of both."

The larger question is how McDonald's can continue to grow at a time when consumers have so many dining-out choices — and when many consumers are turned off by fast food.

And the recently published "Fast Food Nation: The Dark Side of the All-American Meal," only bolsters the well-established belief that fast food is unhealthy.

"The real McDonald's bears no resemblance to anything described in (author Eric Schlosser's) distorted book," McDonald's says in a statement. "He's wrong about our people, wrong about our jobs and wrong about our food."

Whatever the source of the company's problems, a mid-life crisis is a painful transition.

McDonald's response to its current challenges will determine the company's future — whether this quintessential American success story grows old gracefully, or becomes a worn-out relic.